Government debt, output, and asymmetric information

Recent explanation of monetary policy and its effect have centered upon a non-cooperative game involving the monetary authority and the private sector. Notably absent from the discussion of asymmetric information and its impact on decision making is fiscal policy. This note examines a simple model where the fiscal authority determines the optimal ratio of permanent to total government debt based on explicit optimizing behavior. Deficit financing can have short-run effects because of uncertainty concerning future fiscal policy. However, in the long run, changes in net private sector wealth due to government financing policies do not affect private sector behavior.